A Helicopter Tour of Competing Theories of Wage Rigidity, As Applied to the Great Depression Ranjit S. Dighe* SUNY-Oswego Economics Department Working Paper 1998-01 * Assistant Professor, Department of Economics, SUNY-Oswego, Oswego, NY 13126. Phone: 315-341-3480. E-mail: [email protected]. I am grateful to Truman Bewley for his insights into modern-day wage setting, to which the theory I sketch in section III owes a considerable debt. This paper has also benefited from the comments of Lewis Davis, Timothy Guinnane, Christopher Sims, and David Weiman. A Helicopter Tour of Competing Theories of Wage Rigidity As Applied to the Great Depression "Nominal wages and prices came down by half between 1929 and 1933. Why would anyone look at a period like that and say that the difficult problem would be to explain rigid wages? I don’t understand it." -- Robert Lucas1 "Why is it that, when mass unemployment exists, unemployed workers and profit-seeking firms do not immediately arrange employment at lower wages than the prevailing ones, thus forcing the market to quickly find equilibrium? Answering the question does not seem difficult, except perhaps for economists who have acquired through their education an intellectual apparatus that they tend to apply everywhere and, therefore, sometimes in the wrong place: such behavior by firms and unemployed workers would go against social norms and would, therefore, often turn out not to be mutually advantageous." -- Edmond Malinvaud (1984, p. 20) I. INTRODUCTION The Great Depression, as the ultimate example of a persistent labor market disequilibrium in American macroeconomic history, is inevitably seen by many as the ultimate case of sticky wages. Whether one views wage stickiness as a cause or merely a symptom of the mass unemployment of the 1930s, the failure of that unemployment to exert greater downward pressure on wages is striking. The downward rigidity of wages in the Great Contraction of 1929-33, which will be this paper’s primary focus, is all the more so because of the relatively "unfettered" state of the labor market at that time -- unions were weak or non-existent, and government interventions such as minimum-wage laws and unemployment insurance were notably absent. While much has changed in American labor markets since the 1930s, wages remain downwardly rigid. Modern economic theory offers a multiplicity of competing explanations of wage stickiness, and the Great Depression arguably offers a reasonable testing ground for these explanations. That wages were sticky in the Great Contraction of 1929-33 is beyond dispute. Many large companies did not make their first nominal wage cut until mid-1931. From 1929 to June 1931, nominal 1 Quoted in Klamer, 1983, p. 46. "Came down by half" is, of course, an exaggeration. 1 average hourly earnings (AHE, the closest approximation to average wage rates that we have for that period) fell only 4.7%, despite an 11.7% drop in consumer prices and a 19.5% drop in factory wholesale prices and a rise in the nonfarm unemployment rate to 25% (for data sources, see appendix. See Table 1 for an industry-level breakdown of these changes). Even including the final two years of the Contraction, in which real wages actually did fall, the drop in nominal AHE from 1929 to their nadir in June 1933 was 23.6%, still less than the drop in either consumer prices (25.9%) or factory wholesale prices (27.0%). While such aggregates may be somewhat distorted by compositional effects, such as the supposed tendency for firms to lay off their low-paid unskilled workers first, Dighe (1997b) has demonstrated that the net effect of these various compositional biases was small, so that movements in AHE during that time do give a fair approximation of movements in actual wage rates; the picture that emerges is indeed one of sticky wages. Of the scores of theoretical explanations of wage rigidity, this paper evaluates five general types: (1) institutional impediments to downward wage adjustments; (2) market-clearing models of the labor market (Lucas and Rapping, 1969; Bernanke, 1986); (3) efficiency wages; (4) implicit contracts; and (5) insider-outsider models. Normally the economist’s preferred arena for testing competing theories is multiple regression analysis, but this approach is manifestly inadequate for testing explanations of wage stickiness, since so many of these theories do not fit neatly, and in some cases do not fit at all, into a regression framework. Examples include Keynesian relative-wage explanations, near-rationality or menu costs in wage setting, and implicit contract models that stress long-term effects on worker morale. As a result, such theories are rarely tested at all. Nevertheless, using a cross-section of 25 manufacturing industries, I have regressed the 1929-31 percent change in AHE, as well as the 1929 level of AHE, on several industry factors that bear on some, though not all, of the theories under consideration. The results are mixed but show a tendency for wages to be both higher and stickier in industries that relied heavily on short workweeks to "spread the work" -- a result that offers some support for Bernanke’s 1986 model 2 and implicit contract theories -- and in the two printing industries in the sample, both of which had strong unions. We also see a strong tendency for wages to be stickier in industries with more concentrated product markets. Because the regression results are not the heart of this paper -- with such highly aggregated data and so few degrees of freedom, and a pattern of poor fits or fragile results for the wage- changes regressions (which bear more directly on theories of cyclical wage stickiness than do the wage- levels regressions), one rightly hesitates to draw strong conclusions from them -- I have relegated them, along with some brief words on their specifications and data sources, to the appendix. Arguably, a more thorough evaluation of these theories as they apply to the Great Depression requires making use of whatever evidence, both quantitative and qualitative, is available. Section II represents my attempt to do so. Of necessity, the data sources are far-flung. Data on hourly earnings and wage-rate changes are available from regular and special surveys by the U.S. Bureau of Labor Statistics (BLS; Monthly Labor Review, various issues) and the private National Industrial Conference Board (NICB, 1932, 1935, 1940; Beney, 1936). The NICB data provide further disaggregation of workers’ wages, hours, and employment into three distinct occupational groups (unskilled males, skilled and semi- skilled males, females); as we shall see, this information proves helpful in evaluating certain theories. Survey evidence of company and worker motivations appear in key NICB reports on salary and wage policy (1932, 1935) and in Bakke’s (1940) ethnographic study. Basic figures on union membership, strikes, and turnover are available from Wolman (1936), the BLS (1937), and Woytinsky (1942). The accounts of contemporary business consultants (e.g., Babson’s Reports and the Taylor Society’s Bulletin), labor publications, and researchers shed some light on these issues as well. Company archive data -- including internal correspondence of Du Pont officials and of the Special Conference Committee, an extraordinary group of a dozen of the country’s largest corporations that met secretly and regularly to discuss labor issues -- provide important glimpses into what businessmen of the time were saying 3 privately.2 Finally, several recent studies (Colin Gordon, 1994; Wright, 1986; Schatz 1983) provide useful background on industry practices and policies in that era. II. EVIDENCE BEARING ON THEORIES OF WAGE RIGIDITY II.A. Institutional barriers to wage adjustment Institutional impediments to downward wage adjustments include the usual suspects of unions, contracts, minimum wages, and unemployment insurance, all of which have been variously cited as important sources of wage rigidity in the modern era. All of these institutions came into great prominence in the U.S. during the Great Depression, but only after the 1929-33 contraction. An institutional force that was prominent in the Great Contraction, at least in the rhetoric of business leaders, was a shift in business ideology toward avoiding nominal wage cuts because of their supposedly adverse effect on consumer purchasing power (see O’Brien, 1989). This explanation will receive due consideration as well. Since the great mass of factory workers did not belong to a union, the traditional opposition of organized labor to nominal wage cuts was irrelevant to most workers’ actions. Only about one of every ten factory workers in 1929 belonged to a union, and the Great Contraction brought union power to a historic low by mid-1933 (Wolman, 1936, p. 227). With a few exceptions (e.g., the printing unions), the few workers who were unionized received little more protection from wage cuts than did their unorganized counterparts. In the NICB’s 1932 survey of salary and wage policies, wage-rate reductions were nearly as prevalent in union plants (72.7 percent of plants) as in nonunion plants (76.7 percent of plants). The weighted average reduction was actually slightly higher in the union plants than in the 2 Information on the Special Conference Committee -- whose member companies were AT&T, Bethlehem Steel, Du Pont, General Electric, General Motors, Goodyear, International Harvester, Irving Trust, Standard Oil, Westinghouse, U.S. Rubber, and U.S. Steel -- became public only after a Congressional subpoena in the late 1930s. Ozanne (1967, 1968), Gitelman (1991), and Colin Gordon (1994) provide further details on this group. 4 nonunion plants (NICB, 1932a, pp. 28-29). It seems plausible that even in the effectively nonunion 1929-33 period, many employers nevertheless regarded the threat of unionization as a serious factor -- especially in view of the unions’ rapid gains during World War I, barely a decade earlier -- and avoided wage cuts and any other behavior that might have prodded their employees into forming unions.